If you don’t have a great credit score, or a high-paying job, applying for a mortgage can feel scary, or seem like a waste of time.
In order to qualify for a mortgage, ideally lenders look want to see that you have:
- Good credit
- A low debt-to-income level, which means how much of what you make goes toward paying off your monthly debt
- Enough income to pay your mortgage every month
- A job that will provide that income on a consistent and predictable basis
The better your credit score, income, and debt levels are, the more likely you are to be approved, and the better the interest rates and loan terms you’ll be offered.
On the other hand, if you don’t have great credit, or your income and job history leave some question marks, a lender may still approve you, but you just won’t get the best rates and terms. While that might not sound ideal, it probably sounds a lot more appealing than a lender not approving you for a loan at all, and it definitely sounds like the lender believes you’ll be able to handle the monthly payments!
Unfortunately, getting a lender’s stamp of approval may be a bit misleading…
The History and Risk of Subprime Loans
One of the main reasons why the housing market collapsed around 2008 was because so many buyers were being approved for “subprime” loans. These loans were being offered to buyers who had lower credit scores and/or lower incomes, which made them more likely candidates to default.
But to make matters even worse, many of those subprime loans also came with an adjustable rate, which meant that the monthly payments they were initially approved for would increase after a few years, if rates went up. Mortgage rates did end up increasing, and nearly 40% of subprime mortgages ended up in foreclosure.
Looking back on it, the word “subprime loans” certainly sounds like a disaster waiting to happen now that everyone has let the word sink in a bit. But even many people in banking and finance didn’t let the term “subprime” get in the way of thinking they weren’t such a bad product to offer people who wanted to buy a home. So why would the average consumer have thought twice about it?
Unfortunately, many buyers who had subprime mortgages felt duped by the lenders, because they felt that by approving them, the lender had done their due diligence and assessed that the buyers could afford to pay their mortgages. As you can imagine, lenders put the blame on the borrowers for getting in over their heads, and not being good with their finances.
Ultimately, lenders were more to blame because they were the financial professionals in the equation. But yes, homebuyers should have given some thought to whether or not they could truly handle the financial commitment they were making.
Well, regardless of whose fault it was, now they’re back…
Now They’re Called “Nonprime” or “Dignity” Loans
According to realtor.com, subprime mortgages are becoming more common again, but they’re now being called “nonprime” and “dignity” loans, and they’re being offered to potential homebuyers with less than ideal credit scores and histories.
Fortunately, the government and banking industry have taken measures to ensure another “subprime crisis” doesn’t occur, and many experts claim that the current real estate market is much more stable than it was back then, so subprime mortgages shouldn’t create another market collapse.
However, whether you call them subprime, nonprime, or dignity mortgages, they could hurt you as an individual buyer if you’re not fully informed or thoughtful about them.
If you’re approved for a nonprime or dignity loan, you may have been given the green light from a lender to buy a house, but you might want to proceed as if you were given more of a yellow light.
Yes, they’re saying they’ll give you a loan, but you should also give some thought as to whether or not you truly feel you can handle the monthly payments and any of the terms and conditions of the loan they’re offering well into the future.
Do your own math. Really picture yourself over time and be honest about whether you’re ready and capable enough to handle the mortgage. Because ultimately it’s you who will have to deal with the consequences of not being able to handle it, not the lender who approves you.
Does this mean you absolutely shouldn’t buy a house if you’re only able to be approved for a nonprime or dignity mortgage? Not at all. These loans can be great for someone who needs more lenient credit requirements, or who doesn’t have a traditional job or income source, but has a solid and dependable income stream.
Just be aware of the type of loan you’re being approved for, and make sure that you understand and weigh the risks of them before signing on the dotted line.
The Takeaway:
Subprime loans given to borrowers with poor credit contributed to the 2008 housing crash due to high foreclosure rates. These risky loans often had adjustable rates that increased over time, making payments unaffordable for many, and led to many foreclosures.
Today, similar loans are resurfacing under names like “nonprime” or “dignity” loans. Although regulations have improved market stability, these loans still pose risks to individual buyers.
While nonprime loans can help those with less-than-perfect credit or non-traditional income buy a home, it’s crucial to fully understand and consider the risks before committing. If you get approved for such a loan, carefully assess whether you can handle the payments and terms over the long-term.